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Capital One to Redeem $3.65B TruPS

Capital One Financial Corp. (COF) jumped on the bandwagon of companies redeeming trust preferred securities (TruPS). The company announced that it will redeem TruPS worth $3.65 billion. Over the last few months, many financial institutions have been redeeming TruPS, since these will no longer qualify for Tier 1 capital ratio calculations beginning 2013.

The redemption includes Capital One Capital (Series II to VI) TruPS worth $3.5 billion, Coastal Capital Trust II valued at $10 million, North Fork Capital Trust II worth $100 million and Reliance Capital Trust I worth $45 million. All the redemptions will take place on January 2, 2013.

Capital One Capital (Series II to VI) TruPS and Coastal Capital Trust II would be redeemed at 100% of the total principal amount and will include accrued and unpaid distributions until the redemption date. Moreover, North Fork Capital Trust II will be redeemed at 101.9035% of the aggregate liquidation amount while Reliance Capital Trust I would be redeemed at 102.451% of the aggregate liquidation amount. Both will comprise accrued and unpaid distributions until the redemption date.

Redemption of TruPS will enable Capital One to lower its interest expenses as these securities demand higher rates compared to others. The company’s interest expenses were $1.8 billion for the nine month ended 2012. Further, the redemption will lead to a reduction in the company’s long-term borrowings, which will go a long way in improving its overall financials. As of September 30, 2012, Capital One’s total debt stood at $38.4 billion compared with $34.3 billion as of September 30, 2011.

TruPS redemption is viewed as a positive step for the banks, enabling them to bring down interest expenses, as these securities demand higher rates than other securities and often the banks replace TruPS with equity or other low-cost debt. Further, according to the Dodd-Frank Act, banks will no longer be able to consider these securities as regulatory capital beginning 2013.

Currently, Capital One retains a Zacks #3 Rank, which translates into a short-term Hold recommendation. We believe that the redemption of TruPS will be an appropriate step for the company, leading to positive estimate revisions. This, in turn, could lead to an improvement in the Zacks Rank. We also maintain a long term ‘Neutral’ recommendation on the stock.